13 Dec 2010
Since the equity markets reached a high in October of 2007, there has been a double digit correction followed by a sharp double digit rally, which has made for a very challenging investment environment. While most broad based equity averages remain well off their highs reached in late 2007, the average hedge fund has recently exceeded its high-water mark and has drastically outperformed its traditional counterparts.
For the three year period ended October 2010, the Hennessee Long/Short Equity Index is up a respectable +6.10% relative to the S&P 500 Index which is off -22.49% and the Dow Jones Industrial Average which is off -19.99%. In a prior research paper (see Long/Short Equity Hedge Funds React to Global Downturn), the Hennessee Group estimated that the average net exposure of long/short equity hedge funds decreased by -16%, from +52% at the end of the second quarter of 2007 to +36% in the second quarter of 2008. This reduction in risk exposure allowed the Hennessee Long/Short Equity Index to outperform by a wide margin during the equity market sell-off. Specifically, from October 2007 to February 2009, the S&P 500 index lost -51.85% and the Dow Jones Industrial Average lost -49.17%. Over this same time period, the Hennessee Long/Short Equity Index lost -18.25%.
According to recent Hennessee Group research, hedge funds gradually increased equity market exposure to participate in the market rally that commenced in early 2009. Hennessee Group estimates that long/short equity hedge funds increased their net exposure by an average of +22%, from a low of +34% in the fourth quarter of 2008 to +56% in the first quarter of 2010. In addition, hedge funds increased their absolute gross exposures by an average of +73% over the same time period, from a low of +106% to a high of +179%. Hedge funds increased their net exposures in reaction to the market bottom largely by increasing their long exposures more than their short exposures. The increase in equity market exposure has benefited hedge funds as the Hennessee Long/Short Equity Index was up +29.80% from the beginning of 2009 through October of 2010. While short positions and hedges were the primary detractors from hedge fund results during the strong equity market rally, hedge fund managers also struggled with other market dynamics such as the spike in correlation amongst individual securities. The elevated levels of correlation, due in large part to macro sentiment driving stock prices rather than fundamentals, has made for a very challenging investment environment, particularly for fundamentally based managers.
“The Hennessee Group believes a key driver of this outperformance by hedge funds has been their ability to successfully navigate through these highly volatile and uncertain market environments by adjusting their equity market exposures,” said Mr. Gradante, Managing Principal of Hennessee Group. “Specifically, hedge funds protected investor capital during the severe market correction that commenced in late 2007 by reducing net portfolio exposures and also participated in a good portion of the recent equity market rally by once again adding risk exposure following the financial crisis.”
For the three year period ended October 2010, the Hennessee Long/Short Equity Index is up a respectable +6.10% relative to the S&P 500 Index which is off -22.49% and the Dow Jones Industrial Average which is off -19.99%. In a prior research paper (see Long/Short Equity Hedge Funds React to Global Downturn), the Hennessee Group estimated that the average net exposure of long/short equity hedge funds decreased by -16%, from +52% at the end of the second quarter of 2007 to +36% in the second quarter of 2008. This reduction in risk exposure allowed the Hennessee Long/Short Equity Index to outperform by a wide margin during the equity market sell-off. Specifically, from October 2007 to February 2009, the S&P 500 index lost -51.85% and the Dow Jones Industrial Average lost -49.17%. Over this same time period, the Hennessee Long/Short Equity Index lost -18.25%.
According to recent Hennessee Group research, hedge funds gradually increased equity market exposure to participate in the market rally that commenced in early 2009. Hennessee Group estimates that long/short equity hedge funds increased their net exposure by an average of +22%, from a low of +34% in the fourth quarter of 2008 to +56% in the first quarter of 2010. In addition, hedge funds increased their absolute gross exposures by an average of +73% over the same time period, from a low of +106% to a high of +179%. Hedge funds increased their net exposures in reaction to the market bottom largely by increasing their long exposures more than their short exposures. The increase in equity market exposure has benefited hedge funds as the Hennessee Long/Short Equity Index was up +29.80% from the beginning of 2009 through October of 2010. While short positions and hedges were the primary detractors from hedge fund results during the strong equity market rally, hedge fund managers also struggled with other market dynamics such as the spike in correlation amongst individual securities. The elevated levels of correlation, due in large part to macro sentiment driving stock prices rather than fundamentals, has made for a very challenging investment environment, particularly for fundamentally based managers.
“While hedge funds have reduced exposures again in recent months as the sovereign debt crisis and other macro issues have overshadowed the markets, they remain elevated relative to historical levels and we believe managers will continue to maintain them as the global economy continues to recover and the equity markets further stabilize,” stated Mr. Gradante, Managing Principal of Hennessee Group LLC. “That said, we believe they will remain cautious as there a number of headwinds that continue to trouble managers. We also expect security selection to be more of an alpha generator going forward as opposed to the exposure adjustment we have witnessed in recent years, particularly as fundamentals begin to matter and we see more dispersion between sectors and stocks.”
